DXP Enterprises (DXPE)

Positive and increasing FCF since 2001. CROIC is also above average 17%. Although FCF has been increasing every year, long term debt has increased dramatically as well.

One thing that caught my eye is that the company has a habit of increasing accounts receivables and inventory while if there were reductions, the percentage amounts were very small.

I’m not sure whether it is just DXPE or industry specific, but COGS is very high and although gross margins at consistent around the 28% mark, net margins are quite thin at 3.5%. This is why I can see that DXPE has trouble converting sales into FCF.

Price as of writing: $11.96

DCF: $19.92

Graham Formula: $19.23

EPV: $13.89

Portfolio Recovery Associates (PRAA)

PRAA still looks to be a good company. I figured the company would be worth around $47-$60 last year so it seems to have reached its intrinsic value.

The business collects payment from delinquent consumers..

After looking at ASFI, I’ve realized what a profitable niche industry this is if done correctly. Profitable because these types of companies buy bad receivables from many companies at a discount to its true value.

PRAA could buy a list of accounts where consumers are not meeting payments on their visa card, at a price significantly cheaper than the real value.

e.g. if PRAA buys a portfolio from visa for $1m where the original value of the receivables is $2m. So even if they can’t get the full 100% from consumers, if the company can collect about 80%, they are still making profit because the business buys 50c dollars.

Price as of writing: $47.09

DCF: $47.45

Graham Formula: $65.94

EPV: $25.62

j2 Global Communications (JCOM)

Currently debating with myself whether JCOM will make a good investment.

The company offers messaging services such as fax, voicemail, email and call handling services.

FCF has been increasing since 2002 and even in 2008 and 2009, seems like revenue is at an all time high. Even in the previous dot com recession, JCOM was able to continually increase their profit.

Gross margins are above 80% and net margin just around 30%. That’s quite impressive. It indicates the company can increase prices .

No matter what the economy, businesses and people will still need to use email or fax something. With the internet it has become even easier now that you can fax documents through the internet.

8 responses to “2009 Best Small Companies Part 4”

Hello Jae,Great website.. I read it all the time.One thing bothers me though.. in your Excel FCF valuation sheet you exclude changes in working capital from FCF calculation. I don’t think that is right. I actually changed the formula on my sheet to calculate FCF as CFO-CAPEX (actually CFO+CAPEX because CAPEX is a negative number).In case of DXPE, you say that they had positive FCF from 2001.. that is not the case if you include changes in working capital. In 2005 and 2006 they had negative FCF. They have been increasing invesntories and receivables every year.. this is a cash outlay, but you do not account for that in your FCF calculation. Do you agree?

The formula for FCF I use at the moment is based on Buffett’s owner earnings where he states that changes in working capital should also be in (c). If you think about it, if a company is required to increase working capital to meet the current demand, that’s really an increase of maintenance capex.

“If we think through these questions, we can gain some insights about what may be called “owner earnings.” These represent (a) reported earnings plus (b) depreciation, depletion, amortization, and certain other non-cash charges such as Company N’s items (1) and (4) less ( c) the average annual amount of capitalized expenditures for plant and equipment, etc. that the business requires to fully maintain its long-term competitive position and its unit volume. (If the business requires additional working capital to maintain its competitive position and unit volume, the increment also should be included in ( c) . However, businesses following the LIFO inventory method usually do not require additional working capital if unit volume does not change.)” – 1986 Berkshire letter

Also, since I haven’t found a single person who can accurately judge or calculate maintenance capex, I just use the total capex which will more than offet the working capital required for maintenance.

Some other points is that owner earnings is used to judge the true earnings or cash flow of the company. I just use the phrase FCF more often because most people don’t understand what owner earnings is. So by excluding changes in working capital it may actually be safer in some circumstances because current assets and liabilities are more easily manipulated and can vary by large degrees year to year which won’t provide an accurate picture of the business.

By including changes in working capital you are actually calculating FCFF which shows how much cash flow is available for distribution to shareholders of the company. I don’t believe this reveals the earnings power of an ongoing business because you are only looking at things 1 year at a time and calculating the business as if it will disperse all its cash which is unlikely in any organization.

I should write a post on this in the near future. Great question because it’s been something that I’ve been thinking about for weeks after someone mentioned it as well.

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